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Backdoor Fannie Mae Subsidy Could Hit Taxpayers

NEW YORK (TheStreet) -- As with the rescues of General Motors (GM) and AIG (AIG), the repayment of government bailout money by Fannie Mae (FNMA) and Freddie Mac (FMCC) will likely hinge on a backdoor taxpayer subsidy.

In a Securities and Exchange Commission filing earlier in March, Fannie Mae said it would delay filing its 2012 financial report as it considers releasing a $61.5 billion deferred tax valuation allowance.

The potential release would bolster Fannie's earnings and capitalization, in a move the company said could help it begin repaying the U.S. Treasury on a $100 billion-plus taxpayer supported bailout.

The key is that if a company can return to profitability, it can use its deferred tax assets (DTA) as a shield against tax on future profits.

Such a scenario could mean Fannie would be repaying one arm of the U.S. Treasury using lost revenue to another.

"The release of the valuation allowance would have a material impact on the company's 2012 financial statements and result in a significant dividend payment to the U.S. Department of the Treasury" under the terms of its $116.1 billion preferred stock investment, Fannie said in the March 14 filing.

Fannie's deferred tax valuation stems from gargantuan losses the government-sponsored housing entity suffered during the financial crisis as its loans and investments soured. Those valuations are similar to multi-billion deferred tax assets held by AIG on the souring of its securities portfolio and by General Motors on large operating losses.

Smart Money sticks to GSE preferred shares.

Crucially, while both AIG and General Motors have converted their deferred tax valuation allowances to assets, Fannie Mae is just considering converting its $61.5 billion valuation as the mortgage authority becomes solidly profitable.

But for companies like Fannie and its counterpart Freddie Mac, AIG, General Motors or bailed out 'Too Big to Fail' banks like Citigroup (C) that received government support in the financial crisis, deferred tax assets can work as a quiet subsidy as firms repay taxpayer funds.

Were Fannie to get its way, the company would be able to add up to $61.5 billion in capital in an accounting move that would go a long way in repaying the government's preferred investment.

But while Treasury may see billions come in the door by way of its preferred stock repayment, it could lose a similar amount in lost taxable income.

"All you are doing is depriving one part of Treasury from revenues so another department can receive them," says Robert Willens, an independent tax expert.

As was the case for Citigroup's return of government money or AIG's recent full repayment of taxpayer dollars, deferred tax assets played a crucial role in helping to recapitalize the companies and put them in a position to return government money.

At GM, a $30 billion-plus deferred tax asset is also helpful, even if Treasury remains a large investor in the company.

There is nothing insidious about such a scenario also playing out for Fannie Mae, given the basic way losses can be transformed to deferred tax assets, according to Willens.

Still, Willens questions whether Fannie, Freddie or AIG and General Motors deserved to retain their deferred tax valuations, even after experiencing a change of control that put them in government hands.

Oftentimes, companies lose their deferred tax assets in a merger, otherwise profitable firms such as Apple (AAPL) and Google (GOOG) could endlessly conduct mergers as a tax shield.

In rescuing Fannie, Freddie, AIG and General Motors, Willens notes Treasury allowed the firms to retain significant deferred tax assets that are crucial to their repayment of government assistance.

"It should be noted that these companies, which arguably had experienced an "ownership change" when the government took majority stakes in these companies, were able, through the munificence of the Treasury Department and the I.R.S., to avoid the adverse impact on their deferred tax assets that normally accompanies such an ownership change," wrote Willens in a March 20 client note.

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